by the author of dead companies walking

wall street gives biased advice. in other news, the sky is blue, water is wet

Last week it was widely reported that regulators slapped a $43.5 million fine on multiple investment banks for passing off overly positive research analysis on the now private retailer Toys R Us. They did this hoping to curry favor with the current owners of Toys so that the company might pick those Wall Street firms as bookrunners for a possible Toys initial public offering.

I was shocked to hear this. Not shocked because news broke that some purportedly objective research from Wall Street turned out to be bogus, but because that is news at all. By now, I figured everyone–and I mean everyone–knew that recommendations from Wall Street always have been and always will be skewed at best and flat-out misleading at worst.

After the dotcom bust of 2000, then-New York Attorney General Elliott Spitzer accurately revealed that an awful lot of Wall Street firms were using stock recommendations to bring in banking business from the companies they praised. Every institutional money manager with a brain already knew that and treated those recommendations with healthy skepticism. Those who failed to do so lost their jobs because of horrid performance. A few years later, many of those same Wall Street firms sold unwitting customers pools of risky subprime mortgage debt that the firms themselves had secretly bet would fail. How’s that for customer service?

Can you imagine Apple selling an iPhone that exploded in people’s faces—and buying insurance policies to profit on their injuries? Of course not. It would rightly go bankrupt and its executives would most likely wind up in prison. And yet, that’s pretty much what top firms like Goldman Sachs got away with doing in the wake of the financial crisis. So, yeah, color me unsurprised that they’re peddling less-than-objective research to make a few bucks now. They’ve already proven they’re willing to screw their own customers (and blow up the world’s economy!) if it benefits them. Why would anyone think they’d do any different when it comes to research and analysis?

The legendary economist and former Federal Reserve Chairman Paul Volcker rightly said the only new financial product that has helped America in the last few decades was the ATM machine. Yet six years after the financial crisis, needed reforms that might prevent a future crisis have not been enacted. This includes a clearinghouse for financial derivatives or a law preventing anyone from buying credit default insurance on investments they do not currently own. Incredibly, Wall Street was able to get some post-crisis reforms on derivatives trading rolled back this past week by sneaking a provision into a government spending bill.

We’ve got things backwards in America these days. Our corporations, by and large, are over-regulated, while our financial system is under-regulated. We need to flip this dynamic around. We need to free up our great private sector to spur growth, create jobs, and offer products and services that—get this—actually benefit the people who buy them. At the same time, we need to put a much tighter leash on Wall Street.

Most importantly, when a big firm like Citi or Goldman gets itself into trouble by making reckless investments, we should allow them to suffer the same fate as any other American corporation that makes poor business decisions: bankruptcy. If I read one more article in the New York Times about how the biggest mistake we made during the financial crisis was letting Lehman Brothers go under, I’m going to pull out what’s left of my hair. That was one of the few things we did right, and we should have done the same for the other failing financial institutions. Bailing them out, as this week’s news shows, only made them bolder and less trustworthy than ever.

"[Scott Fearon's] insights on the common ways that mature companies often doom themselves apply equally well to start-ups. Every business, young or old, needs to avoid the ... mistakes that he outlines."

About the Author

Scott Fearon has spent thirty years in the financial services industry.
Since 1991, Scott has managed a hedge fund in Northern California that invests in fast-growing companies with little or no Wall Street coverage while shorting the stocks of distressed businesses on their way bankruptcy.